Case Study: Dental Practice Owner Cuts Effective Tax Rate From 37% to 18% Through Entity Restructuring

The Situation: High Income, Higher Taxes, No Strategy

The owner of a successful dental practice in suburban Charlotte, North Carolina, was generating $850,000 in annual net income. The practice had been operating as a single-member LLC since it was founded, and all income flowed directly to the owner's personal return on Schedule C.

The tax consequences were severe. As a Schedule C filer, the entire $850,000 was subject to self-employment tax. On top of that, the owner was in the 37% federal income tax bracket, owed the 3.8% Net Investment Income Tax (NIIT) on investment income, and paid North Carolina state income tax at 4.5%. His previous CPA filed accurate, compliant returns each year, but there was no proactive tax strategy in place. No entity planning, no retirement plan optimization, no real estate integration, and no expense structuring.

When this client came to AE Tax Advisors, his annual federal tax liability was approximately $314,500 on the $850,000 in practice income. His effective federal tax rate was approximately 37%.

Within 90 days of engagement, we implemented a five-part restructuring strategy that reduced his effective federal tax rate to approximately 18%, saving him roughly $160,000 per year.

The Strategy: Five Coordinated Tax Reduction Levers

Strategy 1: S-Corp Election and Reasonable Compensation

The first and most impactful structural change was electing S-Corporation status for the dental practice. Under a single-member LLC filing on Schedule C, the full $850,000 was subject to self-employment tax at 15.3% (12.4% Social Security on the first $168,600 plus 2.9% Medicare on all earnings, plus the 0.9% Additional Medicare Tax above $200,000).

After electing S-Corp status, the owner set a reasonable salary of $250,000. This figure was benchmarked against compensation data for dental practice owners in the Charlotte metro area with similar revenue and experience levels. The remaining $600,000 was distributed as S-Corp shareholder distributions, which are not subject to self-employment tax or the employer portion of payroll taxes.

The math: Before the S-Corp election, the self-employment tax on $850,000 was approximately $39,400 (combining the employee and employer portions of Medicare and the Additional Medicare Tax, since the Social Security wage base was already exceeded). After the election, payroll taxes were assessed only on the $250,000 salary. The net self-employment and payroll tax savings from this single change was approximately $18,400 per year.

Strategy 2: Defined Benefit Pension Plan

With the S-Corp structure in place, we established a defined benefit pension plan for the practice. Unlike a 401(k), which limits employee deferrals to $23,500 (plus catch-up contributions), a defined benefit plan allows contributions that are actuarially determined based on the participant's age, compensation, and target retirement benefit.

This client was 48 years old, which placed him in a favorable contribution range. The actuary calculated a maximum annual contribution of $200,000. This contribution is a fully deductible business expense for the S-Corp, reducing the practice's taxable income before it flows through to the owner's personal return.

The math: A $200,000 pretax contribution at the 37% federal rate generates $74,000 in federal tax savings. The money grows tax-deferred in the plan and is taxed upon withdrawal in retirement, typically at a much lower marginal rate. The plan administration costs approximately $3,000 to $4,000 per year, making the net benefit approximately $70,000 annually.

Strategy 3: Real Estate Purchase and Cost Segregation

The dental practice had been leasing its office space for $12,000 per month ($144,000 per year). We advised the client to purchase the building through a separate LLC for $1,500,000. The practice then paid rent to the real estate LLC at fair market value, creating a deductible expense for the practice and rental income for the holding entity.

We immediately performed a cost segregation study on the $1,500,000 building. The study reclassified 33% of the building's cost basis ($495,000) into 5-year, 7-year, and 15-year recovery categories. The breakdown included dental-specific items such as specialized plumbing for treatment rooms, heavy-duty electrical wiring for dental equipment, custom cabinetry, and site improvements like the parking lot and landscaping.

With 100% bonus depreciation under OBBBA, the entire $495,000 was deductible in Year 1. The building purchase was financed, so the cash outlay was limited to the down payment and closing costs. Yet the depreciation deduction of $495,000 generated a substantial paper loss on the real estate entity's return.

The math: The $495,000 Year 1 depreciation deduction at the combined 37% federal rate plus 3.8% NIIT rate (40.8%) generated approximately $40,000 in incremental tax savings beyond what the prior lease payments were providing. (The lease payments were already deductible, so the net benefit reflects the difference between the old lease deduction and the new depreciation plus mortgage interest deductions, not the full $495,000.)

Strategy 4: The Augusta Rule (IRC Section 280A(g))

The client owned a 4,200-square-foot home with a large dining area, a dedicated home office, and an outdoor covered patio suitable for hosting professional gatherings. We structured 14 board meetings per year at the residence, with the S-Corp renting the home at fair market value for each meeting day.

Based on comparable rental rates for event-quality homes in the Charlotte area, the fair market rental rate was determined to be $5,000 per day. Over 14 meeting days, the S-Corp paid $70,000 in rent to the owner.

Under IRC Section 280A(g), a homeowner can rent their personal residence for up to 14 days per year without reporting the rental income. The $70,000 received by the owner was tax-free. Meanwhile, the S-Corp deducted the $70,000 as a legitimate business rental expense.

The math: The $70,000 deduction at the 37% federal rate generated $25,900 in federal tax savings. The owner received $70,000 in tax-free income, and the S-Corp reduced its taxable income by the same amount. Each meeting was documented with an agenda, meeting minutes, attendee list, and photos of the event setup.

Strategy 5: Accountable Plan for Business Expenses

Finally, we established a formal accountable plan under IRC Section 62(c) to reimburse the owner for legitimate business expenses. Under the prior LLC structure, many of these expenses were either missed entirely or claimed as personal deductions with limited benefit.

The accountable plan covered the following annual expenses:

• Home office (dedicated space for practice administration): $7,200/year
• Business cell phone and internet: $3,600/year
• Continuing education and professional conferences: $8,500/year
• Business travel (conferences, supplier visits): $5,200/year
• Professional subscriptions and memberships: $2,800/year
• Business vehicle use (actual expense method): $2,700/year

Total annual reimbursements under the accountable plan: $30,000.

The math: The $30,000 is deductible by the S-Corp and received tax-free by the owner-employee. At the 37% federal rate, this generated $11,100 in federal tax savings. The accountable plan also eliminates the 2% AGI floor that would apply if these were claimed as miscellaneous itemized deductions (which are not even available under current law for W-2 employees without an accountable plan).

The Combined Results: From 37% to 18%

Here is the full summary of annual tax savings from all five strategies:

• S-Corp election and reasonable comp: $18,400 in payroll tax savings
• Defined benefit plan ($200K contribution): $74,000 in federal tax savings (approximately $70,000 net of plan administration)
• Cost segregation on office building (Year 1): $40,000 in incremental tax savings
• Augusta Rule (14 meeting days at $5,000): $25,900 in federal tax savings
• Accountable plan ($30K in reimbursements): $11,100 in federal tax savings

Total estimated annual tax savings: approximately $160,000

Before the restructuring, this client's federal tax liability on $850,000 was approximately $314,500, an effective rate of 37%. After implementing all five strategies, the estimated federal tax liability dropped to approximately $154,500, an effective rate of approximately 18%.

The cost segregation benefit in particular is concentrated in Year 1. In subsequent years, the ongoing annual savings from the S-Corp election, defined benefit plan, Augusta Rule, and accountable plan total approximately $120,000 to $125,000 per year, still representing a dramatic reduction from the original tax burden.

Why This Matters for Business Owners

This case demonstrates a principle we see repeatedly: high-income business owners operating as sole proprietors or single-member LLCs are almost always paying more tax than necessary. The tools to reduce their burden exist in the tax code. They are legal, well-established, and widely used by business owners who have access to proactive tax advisory.

The difference between a 37% effective rate and an 18% effective rate on $850,000 in income is $160,000 per year. Over a decade, that is $1.6 million in tax savings, money that can be reinvested in the business, contributed to retirement, or used to build generational wealth.

Entity structure is the foundation. Without the S-Corp election, none of the other strategies work as efficiently. The S-Corp creates the framework for reasonable compensation, retirement plan contributions, accountable plan reimbursements, and the Augusta Rule.

Retirement plans are the largest single lever. A defined benefit plan contribution of $200,000 per year is worth more than any other individual strategy for most high-income practice owners. Yet the majority of small business owners are still using basic SEP IRAs or solo 401(k) plans with contribution limits well under $70,000.

Real estate ownership accelerates the strategy. Purchasing the building where you operate your business creates depreciation deductions, mortgage interest deductions, and equity accumulation. Combined with cost segregation, it can generate six-figure Year 1 deductions that dramatically reduce taxable income.

Documentation is everything. Every strategy in this case study requires proper documentation. Augusta Rule meetings need agendas and minutes. The accountable plan requires receipts and substantiation. The defined benefit plan requires annual actuarial certification. Cost segregation requires an engineering report. The S-Corp reasonable compensation needs salary benchmarking support. Without documentation, these strategies become audit risks instead of tax savings.

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This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified tax professional regarding your specific circumstances. AE Tax Advisors, 935 Lake Elmo Dr, Suite B, Billings, MT 59105. Phone: (631) 614-5762.

Note: This case study is a composite illustration based on common client scenarios. Names, details, and exact figures have been modified to protect client confidentiality. Actual results vary based on individual circumstances.

Frequently Asked Questions

Why should a high-income business owner switch from an LLC to an S-Corp?

A single-member LLC reports all net income on Schedule C, subjecting the entire amount to self-employment tax (15.3% on the first $168,600 and 2.9% plus 0.9% Medicare surtax above that). An S-Corp allows the owner to split income between a reasonable salary (subject to payroll taxes) and distributions (not subject to self-employment tax). For high earners, this can save tens of thousands of dollars per year in payroll taxes alone.

What is a defined benefit plan and how much can a business owner contribute?

A defined benefit plan is a type of qualified retirement plan that allows significantly larger annual contributions than a 401(k) or SEP IRA. Contribution limits depend on the participant's age and compensation, but business owners in their 40s and 50s can often contribute $150,000 to $300,000 or more per year on a pretax basis. The contribution is a deductible business expense that reduces taxable income dollar for dollar.

What is the Augusta Rule and how does it create a tax deduction?

The Augusta Rule, under IRC Section 280A(g), allows a homeowner to rent their personal residence for up to 14 days per year without reporting the rental income. When a business rents the owner's home for legitimate business meetings, the business gets a deduction for the rental payment and the owner receives the income tax-free. The rental rate must be at fair market value, documented by comparable rental rates in the area, and the meetings must have a legitimate business purpose.

Can a business owner perform cost segregation on their office building?

Yes. If a business owner purchases the building that houses their practice or office, a cost segregation study can reclassify components of the building into shorter depreciation categories. Items like specialized electrical, plumbing, cabinetry, flooring, and site improvements can be moved from the 39-year commercial building category into 5, 7, or 15-year categories. With 100% bonus depreciation, these reclassified components can be fully expensed in the first year.

What is an accountable plan and how does it reduce taxes for business owners?

An accountable plan is an IRS-approved arrangement under IRC Section 62(c) that allows a business to reimburse employees, including the owner in an S-Corp, for legitimate business expenses without the reimbursement being treated as taxable income. Qualifying expenses include a home office, cell phone, internet, business travel, professional development, and business-use vehicle costs. The business gets a deduction, and the employee receives the funds tax-free. The plan must require adequate documentation and return of any excess reimbursement.